The FOMC has held rates steady at a Fed Funds range of 2.25% to 2.50% for a third consecutive meeting. The last rate hike of 25 basis points came in December 2018 as the FOMC, but in 2019 the Fed has become increasingly cautious. This resulted in the March dot plots guiding for no more rate increases this year. The market then quickly moves to price for the end of the tightening cycle all together. Furthermore there is the expectation that the FOMC will move to cut rates by the December meeting. How does this meeting play into this expectation?
This is not a meeting with any dot plots or changes to economic forecasts, so the changes on the FOMC statement will be poured over for their significance. The US economy is doing fine, and US data does not suggest anything to be overly worried about with regards to any impending sharp slowdown. So the one key factor the market is going to be concerning in the coming meetings is inflation. Inflation dropped to +1.6% on core PCE this week, a 15 month low, and 40 basis points below the Fed’s 2% target. How does the Fed react and is the expectation that this is a transitory decline. Furthermore look for changes to the “patient” stance.
The graphic below from ZeroHedge shows the changes to the FOMC statement.
As can be seen, the Fed has done little to change the statement. The FOMC remains “patient” but has acknowledges the decline in inflation. This will do little to shift the expectation that a rate cut could actually be in the pipeline. Whilst this is still likely to be a temporary decline in inflation (oil price rallying 40% in 2019, wages strong above 3%). The only question that Powell needs to answer is how long inflation is expected to be under target. Use of the word “transitory” from Powell should help to support the dollar.
The Fed guidance in March put a pin in the hiking cycle. However, this meeting was all about stabilisation and reacting to declining inflation. Furthermore, this could now be the beginning of a rather dull run of meetings from the Fed.
We believe that inflation is unlikely to remain subdued at 1.6% on core PCE for long and the market has gone too far in its expectation of rate cuts in 2019. This should ultimately help to support the dollar in the coming months. Inaction on rates is the likely course this year.
In his press conference, Powell was fairly sanguine about global issues which he suggested have “moderated”. His comment on inflation being transitory would suggest confidence that it will bottom out in due course. In response to one question, “some or all of the inflation decrease could turn out to be transient”.
The muted reaction to the FOMC statement suggests the market was prepared for the acknowledgment of the decline in inflation. Treasury yields have dropped and the dollar has marginally weakened. A bigger reaction lower on the 2yea Treasury versus the 10 year suggests there is a concern over the impact on near term rates (maintains arguments for a rate cut). However, unless Powell is very cautious on subdued inflation in the press conference the move seems to be fairly well set following a fairly forgetful meeting.
- US 2 year yield (-4bps) – A move lower has accelerated, the March low at 2.16% is key.
- US 10 year yield (-2.5bps) – A close below 2.46% is a concern but it is interesting to see
- EUR/USD (+10/15 pips) – The rebound has continued and is testing next resistance around $1.1265. A closing breakout opens the April rebound high of $1.1325.
- GBP/USD (+10/15 pips) – The strong Brexit related move continues. Next resistance at $1.3130.
- USD/JPY (-5 pips) – A further dip back on the near term corrective move. Support at 110.85 will be watched as a closing break is a negative move.
- Gold (+$4) – another rebound from the support band $1276/$1280 but the initial resistance at $1289 remains in place
- S&P 500 (+6 ticks) – The prospect of looser monetary policy remains and this is supportive for equities.